Latham & Watkins Greater China Practice

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1 Number 386 August 2003 Client Alert Latham & Watkins Greater China Practice Joint ventures are the most popular form of foreign direct investment in the PRC, not only because they were the first business vehicles permitted for foreign investors in the PRC, but also because many foreign companies find it advantageous to work with a PRC partner that is familiar with the local market... Foreign Investment Enterprises in the People s Republic of China The following is a brief summary of the regulatory environment for foreign investment in the People s Republic of China (the PRC ). This summary is not intended to be a comprehensive discussion of the regulatory environment for investment in the PRC, but rather to provide general information for reference purposes only. It should not be relied upon as a substitute for obtaining detailed legal advice. General Introduction to Foreign Investment in the PRC Types of Foreign Investment Enterprises (FIEs) There are several investment vehicles available to foreign companies interested in establishing a presence in the PRC, the most common being sino-foreign joint ventures, wholly foreign owned enterprises and representative offices. Each of these foreign investment vehicles is discussed in greater detail below. Sino-Foreign Joint Ventures In a sino-foreign joint venture a PRC party and a foreign investor enter into a joint venture contract to establish an enterprise in the PRC. The rights, obligations and liabilities of the parties are governed by the joint venture contract and relevant PRC joint venture laws. Joint ventures are the most popular form of foreign direct investment in the PRC, not only because they were the first business vehicles permitted for foreign investors in the PRC, but also because many foreign companies find it advantageous to work with a PRC partner that is familiar with the local market and has established relationships with PRC businesses and government officials. There are two types of joint ventures in the PRC: Equity Joint Ventures (EJVs) EJVs are limited liability companies jointly invested in and managed by a PRC entity and a foreign entity. EJV parties share in the management, profits and losses of the joint venture in proportion to their equity interests. EJVs have generally been more popular than CJVs (see below), primarily because the longer operating history of, and the more extensive body of regulations relating to, EJVs provides foreign investors with a greater sense of certainty regarding their investment. Cooperative Joint Ventures (CJVs) Like EJVs, CJVs are enterprises jointly invested in by a PRC entity and a foreign entity. The CJV is more flexible than the EJV in that the joint venture contract may provide for the foreign party to recoup its investment before the end of the term of the joint venture. Also, CJV parties may distribute profits and bear responsibility for losses in Latham & Watkins operates as a limited liability partnership worldwide with an affiliate in the United Kingdom and Italy, where the practice is conducted through an affiliated multinational partnership. Copyright 2004 Latham & Watkins. All Rights Reserved.

2 accordance with their contractual arrangement, rather than in proportion to their equity interests. Unlike EJVs, CJVs can be set up as either a partnership-type entity without legal person status or a limited liability company with legal person status. Wholly Foreign-Owned Enterprises (WFOEs) WFOEs are limited liability enterprises in which all equity is owned by one or more foreign investors. The main advantage of a WFOE is that foreign investors can retain sole control over the management and financial affairs of the company. Although WFOE applications may be subject to greater government scrutiny than those for joint ventures, recent amendments to the laws governing the establishment of WFOEs have removed provisions which required WFOEs to export products, use advance technology and restricted WFOEs from operating in certain industries that were open to joint ventures. WFOEs are therefore the investment vehicle of choice for those foreign companies who are comfortable operating independently in the PRC. Representative Offices (ROs) ROs are a good option for foreign companies that are interested in gaining experience with, and acquiring a better understanding of, the PRC market, but which don t need to establish formal manufacturing, distribution or other operations in the PRC. ROs are relatively easy to establish and do not require a PRC partner, but they are restricted from engaging in direct business activities, receiving fees for services rendered, directly generating income or signing contracts which generate income. ROs are, however, allowed to engage in liaison activities such as negotiating contracts which are later signed in the name of the parent enterprise located outside the PRC. Other Foreign Investment Vehicles In addition to the foreign investment vehicles described above, there are other options available to foreign companies interested in investing in the PRC. Some examples include: sino-foreign joint stock companies, holding companies and research and development centers. However, because such investment vehicles are much less common than joint ventures, WFOEs and ROs, they are generally viable options only with respect to specific industries. The approval procedures for the establishment of such entities can be burdensome or may require a foreign company to already have an FIE in the PRC. These investment vehicles are beyond the scope of this discussion. Regulations and Industrial Policies Governing Foreign Direct Investment Although the last thirty years have seen the PRC government relax restrictions on foreign investment, the country nevertheless has a planned economy, and the national strategy on foreign investment must conform to national industrial policies. The two primary pieces of legislation embodying this strategy are the Regulations for Guiding Foreign Investment in PRC Industries (the Guiding Regulations ) promulgated by the State Council on February 11, 2002 and effective as of April 1, 2002, and the Guideline Catalogue of Foreign Investment Industries (the Foreign Investment Catalogue ), the most recent version of which was published on March 11, Whether, and to what extent, a PRC enterprise with foreign investment may engage in a given business depends on how that business is categorized under these two pieces of legislation. The Guiding Regulations divides industries into four categories: Encouraged This category includes projects that utilize new agricultural technology, projects for the overall development of agriculture, energy, communications and major industrial materials, projects that utilize new and advanced technology, or that are capable of improving the performance of products 2 Number 386 August 2003

3 or the economic performance of enterprises, projects that meet market needs, develop new markets or improve the competitiveness of products in international markets, projects that economize on energy, raw materials or resources, projects that utilize recycled resources or prevent pollution, and projects that help realize the potential of the resources of the Central-Western regions of the PRC. Restricted This category includes projects that do not employ advanced technology, are not beneficial to the development or improvement of the environment, or are industries that are otherwise subject to restrictions under other laws and regulations of the PRC. Prohibited This category includes projects that endanger national security, harm the public interest, are contrary to public policy, or will have an adverse impact on the environment, natural resources or public health. Permitted Any business not falling within any of the above three categories belongs to the permitted category. The Foreign Investment Catalogue lists specific industries in the encouraged, restricted and prohibited categories. Any industries not listed in the Foreign Investment Catalogue are considered permitted. As the categories names imply, FIEs may freely engage in businesses in the encouraged and permitted categories, may engage in businesses in the restricted category subject to restrictions, and are forbidden from operating in industries classified as prohibited. The PRC has enacted legislation which specifically governs the establishment and operation of each of the foreign investment vehicles discussed herein. With respect to joint ventures and WFOEs, this legislation generally consists of a general law and a detailed set of implementing regulations. These general laws and implementing regulations have all been amended within the last two years to remove many of the more significant barriers to foreign competitiveness in the PRC. In addition to the laws and regulations which specifically govern the establishment and operations of FIEs, the PRC has enacted the Company Law, which contains detailed provisions applicable to all limited liability companies, including FIEs with limited liability. These provisions set forth the requirements with respect to the minimum registered capital, capital contributions, the number of founders, transfers of shares, shareholder meetings, the board of directors, mergers and divestitures, and insolvency, dissolution and liquidation procedures. In the event of any conflicts between an FIE-specific law or regulations and the Company Law, the FIE-specific law will prevail. Establishing Foreign Investment Enterprises The processes for establishing joint ventures and WFOEs are roughly similar, and generally involve three steps: Project Approval: The parties must obtain preliminary approval for the project; Enterprise Approval: Depending upon the size of the investment in the FIE and the nature of its business, investors must obtain approval for the establishment of an FIE from the Ministry of Commerce (MOC), the MOC branch in the jurisdiction where the FIE will be established, the State Reform and Development Committee or the State Council (as applicable, the Examination and Approval Authority ); and Enterprise Registration: Once an FIE has received approval from the relevant Examination and Approval Authority, the investors must undertake to register the FIE with the State Administration for Industry and Commerce (SAIC) and other PRC government agencies (see Section III). 3 Number 386 August 2003

4 The approval process for an RO is somewhat more simple, requiring only Enterprise Approval and Enterprise Registration. Setting up a Joint Venture Preliminary Project Proposal Approval The approval process for a sino-foreign joint venture begins with the PRC party submitting to the relevant Examination and Approval Authority a preliminary project proposal, which is a brief description of the intended FIE s business. Enterprise Approval Once the PRC party has secured approval of the preliminary project proposal, the investors must submit the following documents to the relevant Examination and Approval Authority: an application; a feasibility study (this generally contains the same information as the preliminary project proposal, but in more detail, especially with respect to the technical and economic aspects of the joint venture); an executed joint venture contract and the articles of association of the joint venture; if the joint venture signs a technical assistance agreement, a copy of that agreement; and a list of candidates for the chairman, vice-chairman and directors of the joint venture. The Examination and Approval Authority will decide whether to issue an Approval Certificate with respect to an EJV within three months and a CJV within forty-five days. Setting up a Wholly Foreign- Owned Enterprise Project Report The first step in establishing a WFOE is for the foreign investor to submit a report to the local people s government at or above the county level in the jurisdiction where the WFOE is to be established. The report must include such information as: the purpose of the WFOE; the scope and scale of the WFOE s business; the products the WFOE will produce; the technology and equipment the WFOE will employ; the area and specifications of land the WFOE will use; the specifications and quantities of water, electricity, coal and other natural resources the WFOE will require; and the WFOE s requirements for public utilities. The local government authority will decide whether to approve the project report within thirty days. Enterprise Approval Once the project report has been approved, the foreign investor must submit the following documents to the Examination and Approval Authority: an application; a feasibility study; the articles of association of the WFOE; the name of the legal representative (or the names of the members of the board of directors); a copy of the certificate of incorporation the foreign investor and a certificate of credit-worthiness of the foreign investor issued by a bank with which the foreign investor has business relationships; the written reply from the local people s government of the intended place of establishment of the WFOE (discussed in (a) above); a list of materials that the WFOE will need to import as part of its operations; if the WFOE signs a technical assistance agreement, a copy of that agreement; and where two or more foreign investors jointly apply to establish a WFOE, a copy of the relevant contracts between them. The Examination and Approval Authority will decide whether to issue an Approval Certificate to the WFOE within ninety days. 4 Number 386 August 2003

5 Setting up a Representative Office A foreign enterprise wishing to establish an RO must entrust a PRC government designated agency to file the following documents on its behalf with the Examination and Approval Authority: an application; the parent enterprise s business license issued by the relevant authorities in its home country and its constitutive documents; a certificate of capital creditworthiness issued by a bank which has business ties with the enterprise; a copy of the office lease for the RO and associated real property registration documents (see Section III(4) below); a letter from the parent enterprise appointing the chief representative of the RO and a copy of the chief representative s resume and passport; and a copy of the parent enterprise s latest annual financial report and/or capital contribution certification. The Examination and Approval Authority will generally decide whether to issue an Approval Certificate to the RO within thirty working days. Registration of Foreign Invested Enteprises The following is a partial list of registrations that FIEs must commonly undertake in order to operate legally in the PRC. It is not intended to be exhaustive, as there can be (and usually are) additional registrations required under environmental, customs, municipal, provincial and/or industryspecific regulations. Business Registrations FIE Name Reservation After an FIE has received approval of its preliminary project proposal or project report the investors should register its proposed name with the SAIC and obtain a Company Name Reservation Notice, which would be issued within 10 days. FIE Registration Within thirty days after the Examination and Approval Authority issues an Approval Certificate, the FIE must register with the local branch of the SAIC and obtain a business license, which generally takes about thirty days. The date of issue appearing on the business license will be the date of establishment of the FIE. Enterprise Identification Code An FIE must register with the municipal corporate identification code office in the city where it is located to obtain an identification code. Foreign Exchange Registration Within thirty days after obtaining a business license, an FIE must register with the local State Administration for Foreign Exchange and obtain an FIE Foreign Exchange Registration Certificate. This certificate is required for an FIE to convert or remit any foreign exchange outside of the PRC. Taxes, Finance, Statistics and Customs Tax Registration Within thirty days after obtaining a business license an FIE must register with the State Tax Bureau and the relevant Local Tax Bureau to obtain an FIE Tax Registration Certificate. Finance Registration Within thirty days after obtaining a business license an FIE must register with the local Finance Bureau and obtain an FIE Finance Registration Certificate. Statistics Registration An FIE must register with the relevant local Statistics Bureau and obtain an FIE Statistics Registration Certificate. Customs Registration An FIE must register with the local Customs Office and obtain an FIE Record Registration Certificate before it can engage in import or export. If the company has secured tariff exemptions from MOC in relation to its imported 5 Number 386 August 2003

6 equipment, it must attach the approved list of equipment to the FIE Record Registration Certificate. Land and Building Registrations Land All land in the PRC is owned by the State. If an FIE leases land, it must therefore obtain a PRC State-Owned Land Use Rights Grant Certificate from the local land bureau. Buildings An FIE must obtain a Real Property Ownership Certificate from the relevant real property bureau in order to secure title over any buildings or premises. ROs are required to register their office lease with the local branch of the SAIC. Labor Registration An FIE must register its collective labor contracts with the local labor bureau and have the other labor contracts certified by the local labor bureau. This memorandum is intended only as a synopsis of certain issues of People s Republic of China law for the partners, staff and clients of Latham & Watkins. Office locations: Boston Brussels Chicago Frankfurt Hamburg Hong Kong London Los Angeles Milan Moscow New Jersey New York Northern Virginia Orange County Paris San Diego San Francisco Silicon Valley Singapore Tokyo Washington, D.C. Client Alert is published by Latham & Watkins as a news reporting service to clients and other friends. The information contained in this publication should not be construed as legal advice. Should further analysis or explanation of the subject matter be required, please contact the attorneys listed below or the attorney whom you normally consult. A complete list of our Client Alerts can be found on our Web site at If you have any questions about this Client Alert, please contact Mitchell Stocks, Sabrina Maguire or Jiun Yoong Lim in our Hong Kong office or any of the following offices. Boston Brussels +32 (0) Chicago Frankfurt Hamburg Hong Kong Mitchell Stocks Sabrina Maguire Jiun Yoong Lim London Los Angeles Milan Moscow New Jersey New York Northern Virginia Orange County Paris +33 (0) San Diego San Francisco Silicon Valley Singapore Jake Redway Tokyo Washington, D.C Number 386 August 2003